After a rapid fall, the dollar has retraced some ground. Some are suggesting this means the dollar’s fall is over, but we believe more caution is still advisable.
The US twin deficit1 deterioration remains very firmly in place and central banks are similarly inclined to let loose monetary policy continue in an uneven recovery. Therefore, fundamental drivers for a meaningful reversal seem scant.
We view any potential “taper” move by the Federal Reserve (Fed) as a significant cause to re-think. But while there has been some discussion of this, we believe it’s premature and unlikely to drive markets for most of this year at least.
The last sustained dollar bear market was in 2002. In that period, the first move down before a correction was just over 13% in seven months, as FIGURE 1 below shows. The recent drop has been almost identical, but over a slightly longer period.
Current positioning surveys suggest the short dollar trade is likely over-extended, so a retracement should not be mistaken for a fundamental shift. In 2002, retracement was about 4%; to date, it has been around 2%.